When Cap Rates Are Lower Than Interest Rates

[@CommercialPropertyAdvisors]

Become incredibly successful investing in commercial real estate even when interest rates exceed cap rates with the help of a mentor! Get your mentor here: www.commercialpropertyadvisors.com/protege-program

[@i65capitalinvestments]

Excellent education...thank you...I was stuck!

[@charleskaufman5826]

DEAL MUST CASH FLOW, DON'T BASE ON JUST EQUITY INCREASE. Using your example, over 5 years the NOI increased to $127,500 which increased the price to $2.55M at 5% THE BIG BUT..... Over the 5 year period if the Cap rate increases to Cap = 6.375% NOW the Price is back to $2M. You just lost the 5 year equity Increase, But if you have CF then you are still good, THEREFORE the property must CF, To many investors are buying properties that are Not cash flowing and when time comes to get new commercial loan they are going to loss their property. If I am wrong please make to video explaining, I have been following you for years and thanks for the great education but always more to learn.

[@CommercialPropertyAdvisors]

Cap rates rarely increase. Over the past 20 years, it's very hard to find an increasing cap rate area just about anywhere. One possibility would be an area that completely collapses due to a freak situation, such as if what happened to East Palestine Ohio due to the train derailment contamination. If an area suddenly went from thriving to struggling, then it's possible for the cap rate to drop. But so long as you choose your areas wisely, the likelihood of a drop in cap rate is slim to none. Even during COVID cap rates didn't drop, despite a global pandemic. Sure, cash flow is very helpful, but it's not always as essential as you may think.

[@mikedulrich]

@@CommercialPropertyAdvisors Cap rates go down during good economies and go up during bad economies. The last 10-15 years have been strong, so we've seen cap rates come down for several years, but a recession could push rates back up towards historic averages.

[@charleskaufman5826]

@@CommercialPropertyAdvisors But Cap Rates do change, Many areas that I have looked at from 2018 until 2021 were 7 cap areas, then as interest rates were still dropping "seems all the sudden" the same 7 cap areas were 4.5 and 5 caps even the commercial properties such as the Auto Zones, Wal-Greens, etc are still low cap 5 with not much time on lease. The multifamily that were 7 caps now trading with low interest rates "3%" started going to 4 Caps and either not cash flowing or very little. Now as Interest rates and cap rates now increasing "interest rates 6%" and cap rates still low but must start coming back up will wipe out any equity increases these investor had buying these non-cash flowing deals. When time to refinance these loans "5 to 10yrs", with these higher interest rates and cap rates will make the asset price drop in value and be very hard to get financing on a property that may only be worth 75% of the original value. The property must CF in most cases at purchase or soon after or I believe the investor is sitting up for failure. Even the CF can be wiped out by increasing cost but that is inflation and why rents must increase. Lots of investor are buying without cash flow or very little the must be very careful, but seems that is who we are competing with these days. Thank You very much for the response.

[@blessed7fold]

​@Commercial Property Advisors What happens when the risk free rate of return rises much higher then cap rates? Who wants to invest in lower yielding investments and then take a lot of risk on top of that?

[@CommercialPropertyAdvisors]

In most markets in US for multi-family, I wouldn't bet on cap rates going up.

[@RandalColling]

Thanks Peter... The only trouble is *DEBT SERVICE*. Most lenders want the income to cover 1.25X the debt service. Getting a loan on a negative cash flow deal based on speculative rental increases is almost impossible, most lenders would require additional collateral or a much larger down payment. A hard money lender will hurt you bad.

[@blessed7fold]

@10th grade drop out Good point and that's one of the reasons why he used an example without financing. I mentioned in a comment above that this advice about rent appreciation is only specific to multi family. It would not work for another asset class like STNL &MTNL.

[@RandalColling]

@@blessed7fold What is STNL & MTNL?

[@blessed7fold]

@@RandalColling Single Tenant Net Lease/Multi Tenant Net Lease

[@shannonwood882]

@@blessed7fold My commercial leases have incremental increases per year.

[@ohanachemdry808]

This is why he mentioned creative financing like OWC at say 4.5% using his example or a master lease agreement....the point being you need to work the numbers and exit strategy and if the CAP rate doesn't then adjust your offer valuation too because no matter what the comps say, it is only worth what makes the most business sense and if there is no win win, move to the next deal....it is only limited to the negotiating parties skills...

[@rex9413]

I'm not sure it would be fair to assume 5% rent hikes over the next 5 years, especially in light of the tremendous rent hikes we experienced in the last few years. While I don't expect rent to decrease meaningfully, I would personally prefer to err on the side of conservatism when underwriting in the current uncertain environment. Moreover, if the fed stays at a higher interest rate level (more like a normal level when compared historically), it's very possible cap rates could rise in the next few years. However, I agree that being pencils down is not a good strategy, and my personal approach is to lead with creative financing (eg seller financing). Never stretch your assumptions during underwriting, and build in more conservatism and larger margins of safety in your pro forma models during market uncertainty.

[@MrHav1k]

Yep. 5% per year is ridiculous!! Very optimistic assumption. That's where this video misses the mark and goes off the rails. I love Peter, but we have to be more conservative. 3% a year would be more realistic and even then rents are flatlining or even starting to fall in many markets. You have to be careful.

[@blessed7fold]

​@TheHvk Before the 'Great Inflation' hit us 5% rent appreciation was conservative but like you said rents have been raised so much in the last 12-18 months that there is no spread left in most multi family markets. Rents are going to go flat if not fall at some point. This information is not up to date with where markets are right now.

[@CommercialPropertyAdvisors]

Rising rental rates are ultimately a function of supply and demand.

[@shagenefu]

I agree, my question is what was the value add for the tenants to justify a 5% per year rent hike?

[@deltadigger2833]

I'm here in CA and I see some job losses already taken place. Rent increases tuff in an economy where food has to come first.

[@blessed7fold]

The advice given here about forced appreciation through raising rents 5% a year works for multi family if rents do not soften but it would not work for another asset class like STNL or MTNL unless they were way below market rents. It should be noted that this advice is very specific to multifamily. However, it should be mentioned as others here have pointed out that interest rates are likely to keep rising which makes the investment worth less and less due to the risk free rate of return being a better and more attractive option for investors with capital to invest.

[@jasonmalabute]

estimating 5% rent growth for next 5 years in any market without considering that market's historical rent growth from 2000-2020 and that rent has been dropping since 2022 in some markets is not conservative

[@mikedulrich]

I'm not confident in some of the assumptions made in this video but a bigger issue the video didn't mention is cashflow. Using some rough numbers based on the assumptions in this video, a property would probably have negative cashflow for several years. This depends on the exact terms of financing but almost any traditional financing will result in negative net income. Even with the optimistic assumptions in this video, it's likely 7+ years of negative income. If the assumptions pan out, it may be worth taking annual losses if those losses can be offset when selling the property but not many people can afford to lose money on a deal for several years. And if the assumptions don't pan out, say you can't raise rent 5% annually or cap rates go up (both of which happen in down economies) an investor may need to hold a property for over a decade to break even when selling (all while losing money each year on expenses). This changes a bit if you can secure very favorable non-traditional financing but you'd still be relying on strong market appreciation.

[@knightlandcompany7875]

Well said! These were our thoughts exactly. Nothing was said about the multiple years of negative cash flow. Elephant in the room.

[@charleskaufman5826]

Yes, this $2M example would have negative cash flow if 30 % down at 6% over 30yrs, WHY would anyone want to have a negative CF as an investment I can do that in the stock market or 401K. Buy good deals with a positive CF, remember the deal need to work for you as the investor and the seller or it is just not a deal!!

[@blessed7fold]

Great point guys. This is why he didn't want to include financing in his example.

[@CommercialPropertyAdvisors]

The video would have had to be double in length to handle the cash flow break even point, etc. This was a simplified example of a multi-family deal to illustrate how you can intelligently invest when cap rates are lower than interest rates. Typically, the investor must account for the early negative cash flow at the time of purchase if their plan is to own long term. Multi-year negative cashflow is rarely sustainable.

[@mikedulrich]

@@CommercialPropertyAdvisors I fine trying to keep videos a reasonable length but it seems like a some mention of negative cashflow was warranted. This wasn't the point of the video but is still an important consideration. Maybe even mention as a teaser for a follow-up video :) Based on some rough numbers, negative cashflows could last 7-12 years which is a lot longer than most investors can stomach. And I'm probably coming across more harshly than I intend. I appreciate your videos but I think this one missed a really important point that could completely change the main conclusion of the video.

[@Dave-rh1ry]

All assuming rents can be raised. Rents are softening.

[@davidferro6773]

I'm seeing rents increased due to migration from the bay area.. Just depends which counties you're looking at..

[@mikedulrich]

@@davidferro6773 Rents are softening even in markets that have done great the last couple years. There will always be some markets that go up, but we're likely seeing a national-level decline in rents. This decline may not last long but that's hard to predict.

[@CommercialPropertyAdvisors]

Rising rental rates are ultimately a function of supply and demand.

[@mikedulrich]

​@@CommercialPropertyAdvisors And the WSJ reported this week that "rents fell in every major metropolitan area in the U.S. over the past six months through January, a trend that is poised to continue as the biggest delivery of new apartments in nearly four decades is slated for this year". So definitely not clear how much rents will be able to increase for the next few years. Obviously not all markets and properties are equal though, so I'm sure there are still viable deals.

[@CommercialPropertyAdvisors]

@@mikedulrich Class A luxury apartments have experienced some changes since that is what builders are building. Our world of investing is Class B and Class C apartments, the sandbox we play in, continues to have strong demand and limited supply.

[@josephtagliente6894]

Peter, I like your videos very much but I have to make a point here. For an investor who is focused on capital appreciation and IRR your scenario works, but for the investor who is looking for cash-on-cash returns and positive cash flow it does not. A mortgage of $1.6M in your scenario would create a monthly debt service of ~$10,113 or $121,356 annually resulting in an annual negative cash flow of $21,356. How can an investor make this work?

[@CommercialPropertyAdvisors]

They account for it upon purchase with a plan as to the break even point or when they will exit.

[@SudeshMehru]

Great presentation. As lenders ask more down payment COC return goes lower than current CD rates which is keeping people ate fence.

[@AlonsoHernandez-z4g]

How did you calculate loan pay down? Thank you

[@robertoinvests]

Love it!!! Thank you!!!

[@abu4729]

Can this math be used for single family home investment properties?

[@CommercialPropertyAdvisors]

Absolutely!

[@jeffreycao8135]

Great video! Quick question on the $100K NOI in your example, is this calculated after taking into account the mortgage (Principal + Interest) payment or before taking into account the monthly mortgage payment?

[@CommercialPropertyAdvisors]

NOI is Net Operating Income and is calculated BEFORE Debt Service

[@mcjproduction]

@@CommercialPropertyAdvisorsYour a great teacher! It’s easier for me to learn from people like you. I wish my teachers in school provided thorough step by step explanations like you.

[@tettsubushi]

Unfortunately, in NYC, for rent-stabilized properties, the HSTPA of 2019 stopped rents dead in the water...

[@myrealtv7830]

Hi, do market cap rates fluctuate? If so, how do you find out what the current market cap rate is for a particular residential apartment building?

[@theadrianfajardo]

They do, the best way to find out are large brokerage firms. Cap rate measures what investors are willing to pay for an NOI. So you need to know how much were properties sold for. Or you can pay for Costar but that's too expensive just to find 1 answer😂

[@gotcomps]

That 5% may be 'very' conservative to owners but what about the paycheck to paycheck renters? We all know that paying a third of your income for housing is nothing more than a rule of thumb - but it's a GOOD & WISE rule, nonetheless. So for example, let's say that you are renting your units for 1k/month - that means that your tenants should be making at minimum, 36k/year, (3k a month) gross. Now if owners were to do what you suggest here, that would increase rents to 1,250/month after 5 years. We all know that incomes are not increasing anywhere close to 5% a year - so do you really want to put so much pressure on your residents by raising their rents a full 50 bucks a year? A household would have to be pulling in 45k/year for 1,250/month rent to be only a third of their gross income. And remember, we're talking gross, NOT net. And let's be honest, a great percentage of renters out here are already paying more than a third on their rent as is. For an owner to increase rents 5% yearly, they are pretty much saying that they want to deal with a higher rate of turnover in the near future. My solution - If the UW doesn't pencil, walk away. Don't make renters pay for owners' mistakes. It may wind up biting you after it's all said and done.

[@ropatipisia4830]

Both husband and wife must work and no more than one child per household. The only way to make it in today's economy. Otherwise the homeless and drug addiction trend will continue to grow.

[@jillmoore8245]

How do you calculate the market cap rate?

[@CommercialPropertyAdvisors]

Good question! I explain that here: www.commercialpropertyadvisors.com/commercial-real-estate-terms/#cap

[@theadrianfajardo]

When he talks about NOI/Price, he is referring to the Yield on Cost. No one can influence the cap rate. This is what confuses people in the topic of cap rate. He mentioned it correctly that the MARKET cap rate is a measure of what investors are willing to pay for an income producing asset. So you can say, the bigger the spread between the Yield on Cost and the market cap rate, the more money you will make ☺

[@UnionCarpenta]

How do you value a apt bldg if the whole building is vacant? There no income coming in, so no NOI.....Correct?

[@wmenghi]

can you make net cash flow and have plenty of reserves per unit?

[@glennstarin3385]

Hey Peter... My name is Glenn Starin...I'm going to be one of your students some day...just not now... But some day... Thank you for your videos... Glenn

[@oldskoolfunk71]

Powerful info Peter. Thank you for all you do.

[@rlew8095]

Great video, thank you!

[@CommercialPropertyAdvisors]

Thank you for watching!

[@ou8michael2]

Great video. I’ve been investing in single-family homes. looking at moving into multifamily.

[@MakuLabs]

Could you do a video on remote investing? Is that a good idea?

[@denisdemidovitch6897]

What if the assumption of raising rents is not viable? Than another option would be to ask for the reduction in the property sales price to maintain adequate cap rate

[@andrewcohen8627]

Great video. Learned a lot

[@endlesspursuits9264]

Thanks for sharing

[@BasicAndSimple]

Thanks for the info Peter.

[@lovelynature8828]

Hello Petter, I really need to talk to you about your program. I tried so hard to reach you. Can you please respond? Thank you.

[@CommercialPropertyAdvisors]

Apply to the Commercial Property Advisors Protege Program here: www.commercialpropertyadvisors.com/protege-program

[@petermckane4834]

Thank you Mr Haris , I always learn

[@SeanHuangRealEstate]

How is this strategy different from when interest rate is low?

[@CommercialPropertyAdvisors]

The lower the interest rate, the higher the cash flow because the debt service is lower.

[@andrewcohen8627]

Thank you Peter.

[@ddfelder2]

Thank you Peter!!!

[@Derek9Lau]

How was the loan pay down of $101,000 derived? Thank you.

[@johnj4006]

Is all the information on your channel in your book?

[@CommercialPropertyAdvisors]

Commercial Real Estate Investing for Beginners (www.commercialpropertyadvisors.com/book) is a great fundamental text on the subject. My videos provide wisdom above and beyond that book.

[@drbayazdentalgroup]

Hi Peter, I feel that I am so lucky to have found you as a Mentor. This probably happens once in a lifetime.

[@paulc4040]

here is a better idea. negotiate a higher "deal" cap rate. there are going to be high default rates this year as many loans need refinancing. interest rates have risen 4% and the cap rates should be 1-2% higher as well. this reduces the asset price quite a bit so the refi of 30/70 loan to equity the owner will either have to come up with more equity/cash since the asset price has reduced due to higher cap rates as well as accept higher interest rate payments or walk away. the bank will have to foreclose and typical liquidation of foreclosed assets yields 60 cents on the dollar.

[@hj007]

Welcome to developing markets. cap rate 9%, interest rate (floating) 11%. Capital gains and inflation will hopefully get you to positive cash flow in a few years, but geared capital growth is where the gains are made.

[@davidferro6773]

One of the things Peter teaches, is to look at the exit, how far below market are the rents? Even if market rents don't increase, or tick down a bit, you could still have upside Every deal is unique, and there out there!

[@stevengreidinger8295]

Your analysis assumes that the typical cap rate for this kind of property in this region will stay the same in the next five years. If you're not sure of that, the deal is risky. If you think the cap rates are going up, the deal could become a loser. The goal of CRE investment is not to speculate on property values and interest rates. The goal is to do some work to lock in a relatively predictable return, possibly with a bit of riskier option value on top, which costs little or nothing.

[@vosk875]

This holds mostly true for value-add transactions with low leverage. Low leverage = lower IRR, Coc and EM

[@wmenghi]

cash flow is hit big with debt service

[@shadyoptics]

Love the video and positivity. Keep in mind a more likely scenario in today’s market…cap rates go up to maintain a normalized spread relative to the “risk free rate” and rents stabilize or decline.

[@johngtran]

Hi Peter, Newbie here but have been passionate and interest in real estate have been over 10+ years. Got my broker license since 2013 but never practice it…but have been part of it around real estate investment and development and around people doing it. I want to say thank you for all your amazing video and learning all the things I need to know especially the “CRE Investment Math”. Keep up the great work as we continue to learn and hear from you. Amazing because you have an engineering background so you breaking it down for an average person to understand is what make you are so amazing. Love to hookup with you soon.

[@emilyalesia2011]

Thank you! You are always helpful!

[@bzldzl]

Basically, book profits and no cash flow.

[@lapiojitarealestateventure4269]

Awesome

[@mikeslifestyletipsreaction833]

The greater the spread, the higher your bread!

[@mondaynighthockeyleague]

Mortgage payment is loan paydown plus interest rate. I wouldnt say the loan paydown its a benefit. You are just getting back the $$ you put in.

[@bob-ov4iq]

So meanwhile , you’re paying out of pocket the 1.5% difference to cover the bank loan?…

[@JohnLewis-gp6hf]

I can understand Mr. Harris's presentations more then others. I am much more interested in learning about commercial real estate investing. I am more interested because I feel like I am learning the process. Much more value this way. Thank you.

[@Aaron_R]

SAVE YOUR MONEY

[@lmartin3601]

You are so passionate about your work. Thank you for taking the time to share this information.

[@DavidAtwell-o4z]

Ya but how much money am I losing every month by operating at a 5.0 cap when interest rates are 6.5%? You kind of breezed past that like it was a non issue.

[@UrR2KBA]

Not the focus of your video, but why would anyone touch that deal? Negative cash flow for years. Maybe some big investors have other properties to offset the losses, but that’s not what your channel is about.

[@utubedude2842]

Now make it work without raising rents

[@nvda2damoon]

the answer is simple - make low ball offer until the cap is at least 2% above the interest! plenty of deals out there to waste time on marginal stuff.

[@scorp2011hd]

I doubt very much your chances of achieving 5% rental increases every year for 5 years… you say you can achieve much higher than that…. WISHFUL THINKING & also EXAGGERATION.